It’s not easy to recognise that the inflation trend has changed

David Jane

Premier Miton Macro Thematic Multi-Asset Team

Our process is designed to minimise the negative effects of natural human biases on fund performance. One that seems relevant right now is recency bias. We have been in a very long period of low and falling inflation. It is difficult for investors to imagine a world in which there is high and rising inflation.

The natural biases that humans have are there for good reasons. They offer effective short cuts for decision making. However, they evolved for a far simpler world than today. Many are very unhelpful for investors. The world of financial markets is especially different from the world which humans evolved to survive in. Our minds are adapted for a hunter gatherer lifestyle, not complex financial markets.

The world of the hunter gatherer was stable, the seasons changed gradually and fairly predictably. Tomorrow, next month and next year would be pretty like the recent past. As a consequence, investors are prone to expect their world to be like the recent past, and in fact, mostly it is. With individual companies, investors expect profits to be similar but higher than the recent past. With bonds, they expect yields to be in recent ranges. This is why trends persist for long periods as investors gradually adapt to changes.

Financial markets also have rapid changes of direction. In simple terms, market cycles have turning points, bull to bear, value to growth, disinflation to inflation. However, many investors take a considerable period to adapt to those changes. Those who recognise the change early are able to perform far better than those who are slow to respond. It is natural to expect things to be like the previous pattern. That is what happened in our distant past, lions were always dangerous and antelope always tasty. However, bank stocks might not always underperform, and bonds might not always rise.

Experience suggests that each new bull phase comes with a new underlying primary trend. Perhaps the last two could be summarised as the rise of China and the lower for longer cycles. It’s early days, but recognising the principal trends which drive the current bull market would likely be very profitable.

Attempting to predict the future would leave us very prone to recency bias as you would naturally expect a future that reverts to the trends of the past. We try to be pragmatic, not having strong views on what is going to happen, preferring to let real data and market action guide our actions.

At present the data, in terms of actual economic data, interest rates, consumer balance sheets and so on, would suggest that inflation will remain relatively high compared to the recent past. Markets are also giving the same signal, inflation friendly stocks are performing well, in many cases rising in the current correction, while the last decade’s growth stocks are weak.

Whether this marks a long-term change of direction will become evident in time, however there are some good reasons to think it does. One of the most compelling is that monetary policy is backed into a corner.

Aggressive rate rises are simply unpalatable, given the scale of government borrowing and corporate debt. While consumer balance sheets are in good shape, financial markets have become very dependent on negative real interest rates. Therefore, monetary tightening is likely to lag, even as inflation rises. The effect of this will be to deflate the real value of the outstanding debt, encouraging the switch to real assets. Businesses and consumers will favour current expenditure over holding cash. These will in turn provide further inflationary pressure, the genie is out of the bottle. Policy makers are happy to allow this to deflate the debt.

We are currently positioned for a higher and more persistent inflationary environment. A near term peak in inflation in the first half of the year is probable, the longer term trend seems likely to be higher. Our process enables us to adapt quickly to such a change, but should the evidence and market signals reverse we will as always be very happy to change our minds.

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Risks

The value of stock market investments will fluctuate, and investors may not get back the original amount invested.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Changes in central bank interest rates can affect all types of assets, in particular, securities such as government bonds and corporate bonds that generally offer a fixed level of interest. If interest rates go up, the value of a bond may fall, and vice versa.

Forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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